ECON305: Public Finance

Unit 1: Introduction to Public Finance and Tools of AnalysisThis unit will begin with an introduction to the tools of analysis that
will be used throughout the course. Most of the models we will use in
this course will be extensions of the supply and demand models you
learned in your introductory microeconomics courses, which will allow
you to evaluate the effects of tax and subsidy policies. These policies
change the relative costs of different activities for the individual
decision-makers. By using rational-choice assumptions—i.e. by assuming
that individuals know what they prefer and, given a choice, will choose
the happier path—we can graphically illustrate the effects of policy
change. Additionally, you will learn how economists use assumptions
about optimality to “add up” individual benefits and costs such that
they reflect social benefits and costs. While economists debate the
appropriateness of certain assumptions, experience using a given set of
tools will help you consider how changes in assumptions might affect the
outcome of the analysis. After this quick refresher, this unit will go
on to introduce major arguments for and against government fiscal
intervention.

From an economic perspective, what is considered “good” government
fiscal intervention? Many economists believe that public goods and
externalities exist as market failures and that the government should
therefore use fiscal policy to affect the outcome in the marketplace.
Public goods are products or services that economists think are not
likely to be provided in ideal quantities because individuals are not
motivated to produce them. If you ask an economist, “What is a public
good?”, he or she will invariably respond: “National security.” In this
unit, we will consider the problem of national security, acknowledging
that in order for individuals in society to be able to conduct their
affairs and accumulate capital, they need assurances that the rule set
they are operating under is somewhat stable. How shall mechanisms for
ensuring this space, such as a large military, be provided? In this
unit, we will learn how economists define a “public good” so that we can
consider whether the particular subsidies from Unit 3.2 meet this
definition. Does national security meet this definition?

We will also take a look at how the dynamics of voting may fail to
overcome the public goods problem when individual voters have different
valuations for the public good before studying tax systems (such as the
Lindahl tax) that seek to overcome this problem. Finally, we will
consider examples in which private persons have provided public goods
despite the existing theory of public goods, which would incline us to
believe that these goods do not exist until they are provided by a
governmental unit that has the power to tax. Consider how people
provided public goods before the advent of modern governments: if
free-rider problems are pervasive, how do public-goods-providing
governments ever get started?

We will conduct a similar investigation into the issue of
externalities. Arthur Pigou, an English economist whose career and
influence bridged the late 19th century and early
20th century, proposed a system of taxation that would
internalize externalities by taxing behaviors such that the private
value would equal the social value. His model was widely accepted,
until a challenge in 1960 from Ronald Coase demonstrated that Pigou’s
model was only a special case. Ronald Coase won the Nobel Prize for
refuting the efficiency of Pigou’s system and, in doing so, opened up a
wholly new way of considering conflicts of interest. This unit will
take a look at Coase’s theorem and his insight into the difficulty of
assigning rights—which often precede our legal understanding of
externalities. We will conclude by considering the possibility of
government failure as an externality.

Instructions: Please open the link above to access the reading.
This reading is on pages 187-194 of Preston McAfee’s textbook and
will explain the significance of the Edgeworth Box and how and why
it relates to Public Finance.

Instructions: When reading the McAfee document, pay particular
attention to the definition of a 'Samuelsonian Public Good'. This
reading is covered by pages 232-233 of Preston McAfee's textbook.
For the Holcombe reading, please click on the second link above to
access the PDF file. When it loads, the referenced reading is in
volume 10, number 1.

Terms of Use: The article above, Holcombe’s “A Theory of the Theory
of Public Goods,” is licensed under a [Creative Commons Attribution
3.0 United States
License](http://creativecommons.org/licenses/by/3.0/us/). It is
attributed to the [Ludwig von Mises Institute](http://mises.org/).
The original version can be found
[here](http://mises.org/periodical.aspx?Id=5&volume=Vol.%2010%20Num.%201).